Spoke in the Wheel – Economic Sanctions Compliance in the Age of Blockchain

Blockchain, the technology that underpins digital currencies such as Bitcoin, has the potential to drastically alter the global financial system. However, developers and market participants must consider the extraordinary reach of US economic sanctions and the magnitude of the penalties for breach.

Blockchain and trade finance

Trade finance is a cornerstone of the global economy to this day. However, it is costly, unwieldy, and slow, with a single transaction often taking weeks to complete.

Blockchain technology uses digitised ledgers of title and assists with execution and settlement, thereby reducing costs, streamlining the cash cycle, and increasing transparency. But as the use of blockchain technology increases, sanctions risks will come into sharper focus for the parties involved.

The impact of economic sanctions

The jurisdiction-based sanctions administered by the US Treasury Department’s Office of Foreign Assets Control (‘OFAC’) generally prohibit “US persons” from directly or indirectly engaging in or facilitating transactions involving individuals, entities, governments, or countries that are the target of OFAC sanctions.

Blockchain technology owned or developed in the United States or by US persons will be subject to US jurisdiction and may also be subject to US export controls depending on the technology used. If the blockchain is owned or licensed by a US person, OFAC may take the view that any transaction using the blockchain – or which involves the selling or licensing of the software - which involves a sanctions target, could trigger the facilitation prohibition.

The Risks

One of the concepts underpinning blockchain technology is that information is verified by multiple users agreeing that the content on the ledger is complete and accurate – the “shared truth”. The integrity of the information is then protected by the ledger protocol. For trade finance transactions, this means that a user will need to input into the blockchain ledger, relevant information from the bills of lading, letters of credit, and other shipping documents.

Failure to enter in all information relevant to sanctions (even if not all of it is necessary for commercial reasons) may expose those involved in the transaction to OFAC or other sanctions risks.

There is also a risk that sanctions might deliberately be evaded if, through collusion between the exporter or importer or even the issuing bank, information is included in the ledger that does not accurately reflect the underlying transaction details.

One potential solution would be for the parties to agree on the information that needs to be entered into the ledger and who will be responsible for the accuracy of the data. Banks could agree that the “mandatory” information will include, for example, basic information such as the name and address of the exporter and the importer, the banks involved, the ports of loading, unloading and transit, the vessels and the insurers as well as the origin and description of the goods being shipped.

Keeping one step ahead

Given that OFAC sanctions are subject to change without notice developers of blockchain technology need to consider a range of issues to ensure they are not unwittingly caught by sanctions. Here, we highlight four sanctions-specific functionalities that developers should consider with a view to mitigating the risks.

For US banks, as well as other US persons, it is important to have the ability to block transactions involving Specially Designated National (SDN) or other blocked persons.

Sanctions provisions should be built into blockchains.

Blockchain technology should include the ability for users to record data in accordance with their regulatory requirements and retrieve all of the data in the ledgers if required to produce the data to the relevant authorities.

Sanctions regimes in their current form cut against the vision of a global financial system underpinned by blockchain technology, a wide-open ledger that disintermediates traditional gatekeepers such as banks and trading houses, and with which governments and regulators cannot interfere.

Ultimately, blockchain advocates will have to submit to the reality of cross-border, extra-territorial regulation, including sanctions. An open and frank discussion on where the sanctions pitfalls lie in implementing blockchain solutions will help developers focus on these commercial and regulatory challenges.